The Bank of Japan, The FOMC and China
So, I took a day to think about what is happening. Last Friday we saw bad news from Non-farm payrolls for the US – and surprise bad news from Canadian Non-farm payrolls. We see consumer confidence dropping- while the Germans at least are experiencing significant manufacturing growth.
The Stubborn BOJ
This morning we saw a new 10 plus year low for the USD/JPY- largely because the Bank of Japan stubbornly refuses to take the fight against deflation seriously, as they made abundantly clear on Monday night. For a generation the BOJ has made Too Little, Too late its motto and operational principle. As a trader my question is simply this: How long will the people and the elected government of Japan continue to tolerate this?
As a trader who uses Fundamentals as part of his decision making process I strongly suspect that patience has largely run out with what the Wall Street journal refers to as the’ World’s Most Incompetent Central Bank.’ We are seeing public rumblings of discontent- and in Japanese culture such open displays of dissatisfaction are very rare.
I strongly suspect that what traders should be watching for is either serious legislative proposals being tabled to curb the Bank or some other political manoeuvre that the BOJ will have to respond to. Remember that the Yen is very seriously overvalued- we should treat it as way overbought. When any stock, bond, commodity or currency becomes massively overbought or oversold what do we expect to see happen? Inevitably. like a rubber band stretched very far out we will see a snap back in the other direction.
So, it seems to me that we should be watching for political developments that threaten the BOJ if they do not take serious action to fight deflation – like a massive expansion of the commercial loan program to include long term corporate bands or mortgage bonds, for instance. At that point the wise trader will look for opportunities to sell the Yen by taking buys on the USD/JPY. CAD/JPY, EUR/JPY, etc. To get an idea of the potential just look at the 1 month/30 year chart and take a look at the size of some of the candles back in the early to mid 1980s.
The Great Stall
Of course, before we get too wrapped up in looking at the BOJ to explain the price of the Yen let us make sure that we temper that enthusiasm by remembering that part of the current price reflects a flight to safety in a pretty scary time. In addition to the economy of the US apparently settling into what some economists are calling The Great Stall there is also continued scary signals coming from China.
Not only has China manufacturing growth slowed very significantly but the Chinese continue to struggle with their banking and debt situation. For instance, this week word came out that China’s banking regulators have ordered banks to transfer ‘off-balance sheet’ loans back onto their balance sheets. These are the Chinese equivalent of the ’securitized’ debt that played such a massive role in the meltdown of the US and world financial system in 2008.
Apparently about $339 billion worth of debt is involved. This debt is separate from the municipal (junk) construction bonds and hidden bad debt owed by Government Owned Enterprises – debt that continues to put the Chinese financial system at risk.
On the FOMC
Part of the reason for waiting to comment in the FOMC decision was that I wanted to see the trade deficit numbers. The US trade gap unexpectedly widened last month. Part of this reflected a drop in exports partly caused by the recent strength of the US dollar- an effect which will now disparate. But part of the gap also reflected a surprise jump in the importation of Capital goods.
Combine this with the surprise drop of US worker productivity plus the fact that in Fridays Nonfarm payrolls private employment was actually up (the drop was due tot he loss of government jobs) and there is a strong hint that the private sector of the US economy has reached the limits of what can be squeezed out of current employees and in fact is beginning to gear up for some serious hiring.
Some of this will happen before the November midterm elections but much may still be on hold until businesses have a chance to see what the new Congress will look like. It seems to me that these factors help us to understand the symbolic action made yesterday by the FOMC. A decision was made to Not allow the massive ($2 Trillion) portfolio of mortgage debt and Treasuries to shrink. Instead, the approximately $20 billion dollars per month that mature and are payed into the Federal Reserve System will be ‘reinvested’ in new long term Federal Treasury debt.
This is just a drop in the bucket when compared to the entire US economy but serves as a reassuring signal to businesses who are starting to plan expansion that they will not be caught in a Japanese style debt/deflation trap. Of course, at least in the short run this is somewhat dollar weakening- as we saw in he initial reaction of the JPY, EUR and GBP to this announcement. Yet, as of the time that I write this both the EUR and the GBP have weakened to below the level where they were before the FOMC issued its statement.
An Important Truth
All of this leads me to remeind myself of an important truth: That headline figues are not the whole story in an announcement, and often times not the most important part of the announcment- sometimes the real meat is not found until you look at the details.
The initial reaction of the market stemmed in part from the fact that a week earlier the members of the FOMC had been signalling that there would be absolutely no changes to the Federal Reserrves policies at the August meeting. Instead, largely because of Friday’s Nonfarm payrolls, there was a symbolic change. After the initial surprise the market finally got the true message:
The FOMC was specifically signalling that it will not repeat the mistakes that the BOJ has made over the last 20 or more years. Short term, this may weaken the US dollar but longer term it probably tends to inspire investor confidence, which may be why the EUR/US has actually dropped some 250 pips in the last 22 hours. Unfortunately, without my participation.