Friday, March 10, 2006
Bank of Japan (BoJ) starts to return back to normal
The Bank of Japan (BoJ) at it's two day meeting this week signalled the nearing end of a fifteen year policy of zero interst rates. One could almost hear the sighs of relief from the Bank of Japan yesterday when it announced the end of its unorthodox policy of "quantitative easing".
Normality comforts central bankers. Being forced to provide large quantities of liquidity to the commercial banks was abnormal and uncomfortable. But in abnormal situations, unconventional policies are the right ones. In ending the policy, the bank is taking a risk with something that matters far more than any discomfort, namely, the stability of the Japanese economy.
The BoJ introduced the policy of quantitative easing to augment the effectiveness of the zero interest rate policy, followed - with a short and disastrous break in 2000 - since 1999. The aim was to increase the liquidity of the commercial banks' balance sheets and so increase the money supply and, indirectly, the commercial banks' willingness to lend.
Today, the quantity of such reserves stands at Y35,000bn (£170bn). This is vastly above the Y6,000bn believed necessary to keep short-term interest rates at zero.
With real economic growth of 5.5 per cent, on an annualised basis, in the last quarter of 2005 and the year-on-year rise in the consumer price index (less food) at 0.5 per cent in January, the bank believed it was time to end those measures. It remains committed to the zero interest rate policy and to outright purchases of long-term government bonds. Only by Japan's standards could yesterday's change be regarded as a significant tightening.
Yet such exceptional measures are justified by exceptional conditions. Two points need to be stressed: the first is that deflation has barely ended; the second is that monetary growth remains feeble.
Note that the consumer price index (less food) in January was still 2.7 per cent below where it had been in December 1997 and was also no higher than in August 2002. Yet price levels as well as changes in price levels matter, since a long period of falling prices has increased the real burden of debt.
Moreover, over the last two years the average rate of growth of broad money has been under 2 per cent. This hardly suggests monetary conditions have been too easy. The withdrawal of excess liquidity may shrink the money supply or at least slow its growth. That hardly seems wise after so long a period of deflation.
Equally important, the BoJ has not accompanied the ending of quantitative easing with a decisive move towards inflation targeting. If Japan is to be a normal country with what is now considered to be a normal central bank, it should attempt to target a rate of inflation of 2 per cent, at least. Instead, we have merely an indication that it is looking at a range of 0-2 per cent.
One benefit from higher inflation is that it would help erode the overhang of debt still present in the economy. Another reason for such a target is that 2 per cent is probably close to an actual inflation rate of zero, given the biases in measurement.
But the most important reason for an inflation target at this level is that it would represent a clear commitment by the bank to end the spectre of deflation. That would be an immense encouragement to anybody thinking of borrowing.
The Japanese experience of the past 15 years has had one clear and overriding lesson: in an exceptional situation, orthodoxy is far more dangerous than its opposite. The Bank of Japan has now taken a step towards the orthodox and is taking a risk in doing so. Let us hope that it will not, as a result, damage the fragile recovery now under way.
Normality comforts central bankers. Being forced to provide large quantities of liquidity to the commercial banks was abnormal and uncomfortable. But in abnormal situations, unconventional policies are the right ones. In ending the policy, the bank is taking a risk with something that matters far more than any discomfort, namely, the stability of the Japanese economy.
The BoJ introduced the policy of quantitative easing to augment the effectiveness of the zero interest rate policy, followed - with a short and disastrous break in 2000 - since 1999. The aim was to increase the liquidity of the commercial banks' balance sheets and so increase the money supply and, indirectly, the commercial banks' willingness to lend.
Today, the quantity of such reserves stands at Y35,000bn (£170bn). This is vastly above the Y6,000bn believed necessary to keep short-term interest rates at zero.
With real economic growth of 5.5 per cent, on an annualised basis, in the last quarter of 2005 and the year-on-year rise in the consumer price index (less food) at 0.5 per cent in January, the bank believed it was time to end those measures. It remains committed to the zero interest rate policy and to outright purchases of long-term government bonds. Only by Japan's standards could yesterday's change be regarded as a significant tightening.
Yet such exceptional measures are justified by exceptional conditions. Two points need to be stressed: the first is that deflation has barely ended; the second is that monetary growth remains feeble.
Note that the consumer price index (less food) in January was still 2.7 per cent below where it had been in December 1997 and was also no higher than in August 2002. Yet price levels as well as changes in price levels matter, since a long period of falling prices has increased the real burden of debt.
Moreover, over the last two years the average rate of growth of broad money has been under 2 per cent. This hardly suggests monetary conditions have been too easy. The withdrawal of excess liquidity may shrink the money supply or at least slow its growth. That hardly seems wise after so long a period of deflation.
Equally important, the BoJ has not accompanied the ending of quantitative easing with a decisive move towards inflation targeting. If Japan is to be a normal country with what is now considered to be a normal central bank, it should attempt to target a rate of inflation of 2 per cent, at least. Instead, we have merely an indication that it is looking at a range of 0-2 per cent.
One benefit from higher inflation is that it would help erode the overhang of debt still present in the economy. Another reason for such a target is that 2 per cent is probably close to an actual inflation rate of zero, given the biases in measurement.
But the most important reason for an inflation target at this level is that it would represent a clear commitment by the bank to end the spectre of deflation. That would be an immense encouragement to anybody thinking of borrowing.
The Japanese experience of the past 15 years has had one clear and overriding lesson: in an exceptional situation, orthodoxy is far more dangerous than its opposite. The Bank of Japan has now taken a step towards the orthodox and is taking a risk in doing so. Let us hope that it will not, as a result, damage the fragile recovery now under way.
# posted by Dr Search- Principal Consultant at the Search Clinic @ 4:35 PM 0 comments
links to this post
Thursday, March 09, 2006
Movement in UK's interest rates unlikely until Bank's next inflation forecast
By the end of the month, the UK may well have lower interest rates than the US for the first time since January 2001. That is the confident expectation of analysts and investors in money markets.
All of the City economists recently polled by Reuters expect the Bank of England to keep interest rates unchanged at 4.5 per cent today.
In the US, futures markets show a 96 per cent probability that the Fed Funds rate will rise by a quarter point to 4.75 per cent on March 28, the first US interest rate-setting meeting to be chaired by Ben Bernanke, the new Fed chairman.
The European Central Bank raised its main interest rate to 2.5 per cent last week and even the Bank of Japan is on the verge of givingup its ultra-loose monetary policy.
In short, monetary conditions are getting tighter in all the main economies of the world, apart from the UK.
Only the UK out of the group of seven leading economies, have interest rates higher than the latest annual growth of nominal gross domestic product.
But the pessimistic view of the economy is no longer one that is held by the overwhelming majority of City analysts.
Those on the other side of the debate are gaining ground and think the wind is swinging in their direction.
More evidence of improving business sentiment by the EEF manufacturers' organisation, whose latest quarterly survey shows much stronger output, order books and investment intentions than three months ago.
But it is not the conflicting views of economists that almost guarantee no action from the monetary policy committee this week. It is the committee's inaction in recent meetings that do not coincide with their quarterly forecasting.
Since late 2001, only two of nine rate changes have taken place in months other than February, May, August or November.
MPC members accept privately that there is a tendency for the committee to avoid difficult decisions in the other months. In the month following the report, they say, doing nothing is easier because there have been insufficient new data since the previous forecasting round. And in the month preceding the next inflation report, the temptation is to wait until the forecasting round itself before taking action.
The new quarterly cycle to UK monetary policy has been aided by the stability of the economy, which has allowed such sentiments to grow to the point thatthey are now included as published justifications for inaction in the MPC minutes.
So while the ECB has begun to deal with what it considers to be a rapidly improving economy, the Fed is continuing to tighten policy for now, and the BoJ is just about to start, all the evidence points to the MPC doing nothing. It is likely to sit quietly next month too, and the real arguments and analysis will take place in May.
All of the City economists recently polled by Reuters expect the Bank of England to keep interest rates unchanged at 4.5 per cent today.
In the US, futures markets show a 96 per cent probability that the Fed Funds rate will rise by a quarter point to 4.75 per cent on March 28, the first US interest rate-setting meeting to be chaired by Ben Bernanke, the new Fed chairman.
The European Central Bank raised its main interest rate to 2.5 per cent last week and even the Bank of Japan is on the verge of givingup its ultra-loose monetary policy.
In short, monetary conditions are getting tighter in all the main economies of the world, apart from the UK.
Only the UK out of the group of seven leading economies, have interest rates higher than the latest annual growth of nominal gross domestic product.
But the pessimistic view of the economy is no longer one that is held by the overwhelming majority of City analysts.
Those on the other side of the debate are gaining ground and think the wind is swinging in their direction.
More evidence of improving business sentiment by the EEF manufacturers' organisation, whose latest quarterly survey shows much stronger output, order books and investment intentions than three months ago.
But it is not the conflicting views of economists that almost guarantee no action from the monetary policy committee this week. It is the committee's inaction in recent meetings that do not coincide with their quarterly forecasting.
Since late 2001, only two of nine rate changes have taken place in months other than February, May, August or November.
MPC members accept privately that there is a tendency for the committee to avoid difficult decisions in the other months. In the month following the report, they say, doing nothing is easier because there have been insufficient new data since the previous forecasting round. And in the month preceding the next inflation report, the temptation is to wait until the forecasting round itself before taking action.
The new quarterly cycle to UK monetary policy has been aided by the stability of the economy, which has allowed such sentiments to grow to the point thatthey are now included as published justifications for inaction in the MPC minutes.
So while the ECB has begun to deal with what it considers to be a rapidly improving economy, the Fed is continuing to tighten policy for now, and the BoJ is just about to start, all the evidence points to the MPC doing nothing. It is likely to sit quietly next month too, and the real arguments and analysis will take place in May.
# posted by Dr Search- Principal Consultant at the Search Clinic @ 10:27 AM 0 comments
links to this post
Wednesday, March 08, 2006
Dollar moves higher as expectations on the Fed grow
The latest hawkish comments from the U.S. Federal Reserve helped push the dollar back to the black in Europe yesterday. This rise in U.S. rate prospects coincides with a decline in expectations over rate increases in both Japan and the euro zone.
St. Louis Fed President William Poole triggered the bullish dollar sentiment by warning that the U.S. economy still has a "great deal of momentum" and that the Fed may have to "step a little harder on the brake" if economic data continue to surprise on the upside.
This helped to give traction to forecasts that the Fed may yet have to raise interest rates as far as 5.50%, from 4.50% currently, by the middle of the year.
Added to this it would appear that investors seem to be taking a more jaundiced view of bullish comments from European Central Bank President Jean-Claude Trichet, who last week hinted that more rate rises are needed to keep inflationary pressures in check.
The dollar also pushed ahead against the yen, as more in the market take the view that the Bank of Japan won't only delay any shift in monetary policy until next month, but that the shift, which will consist largely of a gradual reduction in money-market liquidity, won't actually have an impact on interest rates until early next year.
Data for the day is very quiet from all the majors, with the only piece of note already released in the form of the UK Nationwide Consumer Confidence figure. After a relatively solid +98 last time out the figure materlialised at a still respectable +94 for the month of February.
Overnight tonight we also have the RBNZ Monetary policy statement, and after the cash rate was left unchanged at the latest meeting, look for discouraging signs of further easing later in the year, although sliding domestic demand is fast becoming a theme in New Zealand.
St. Louis Fed President William Poole triggered the bullish dollar sentiment by warning that the U.S. economy still has a "great deal of momentum" and that the Fed may have to "step a little harder on the brake" if economic data continue to surprise on the upside.
This helped to give traction to forecasts that the Fed may yet have to raise interest rates as far as 5.50%, from 4.50% currently, by the middle of the year.
Added to this it would appear that investors seem to be taking a more jaundiced view of bullish comments from European Central Bank President Jean-Claude Trichet, who last week hinted that more rate rises are needed to keep inflationary pressures in check.
The dollar also pushed ahead against the yen, as more in the market take the view that the Bank of Japan won't only delay any shift in monetary policy until next month, but that the shift, which will consist largely of a gradual reduction in money-market liquidity, won't actually have an impact on interest rates until early next year.
Data for the day is very quiet from all the majors, with the only piece of note already released in the form of the UK Nationwide Consumer Confidence figure. After a relatively solid +98 last time out the figure materlialised at a still respectable +94 for the month of February.
Overnight tonight we also have the RBNZ Monetary policy statement, and after the cash rate was left unchanged at the latest meeting, look for discouraging signs of further easing later in the year, although sliding domestic demand is fast becoming a theme in New Zealand.
# posted by Dr Search- Principal Consultant at the Search Clinic @ 12:38 PM 0 comments
links to this post
Tuesday, March 07, 2006
US Treasury yields at 21 month peak
US Treasury yields on Monday hit their highest level since the Federal Reserve began raising interest rates in 2004. The move, which pushed the yield curve inversion to its narrowest in weeks, triggered speculation that the unusual state might be about to end.
Longer dated yields are usually higher than short dated ones since investors charge more for lending for longer periods of time. Any inversion, where longer dated yields are lower, traditionally implies the market is pricing in low returns as the result of a probable economic slowdown.
By late trade in New York on Monday, 10-year notes yielded 4.742 per cent, their highest since June 2004 and just 2.5 basis points below two-year yields.
Monday’s move was an extension of “curve flattening” trade unwinding which began last week after the inversion lost momentum with 10-year yields peaking about 16bp below two-year yields.
UK government bonds were marking time ahead of the Bank of England’s decision on interest rates later in the week.
Hopes of a cut have been damped by a string of data released in in the past couple of weeks showing some economic strength.
While 25 of the 40 economists polled by Reuters still think the next move in rates will be down, the market may have to wait until May for a decision, when the Bank’s rate setting committee will be armed with the next quarterly inflation report.
The yield on the two-year gilt was up 1.3bp at 4.399 per cent and the 10-year yield was down 0.1bp at 4.257 per cent.
European government bonds saw some small price gains, with yields slipping back from last week’s steady increases.
Eurozone data showed a drop in retail sales last month, illustrating the conundrum of lacklustre consumer activity even as exports and business spending accelerate.
The data contrasted with strong manufacturing and services numbers last week that had helped raise expectations of further interest rate rises to come from the European Central Bank. Germany has begun bookbuilding for its first inflation-linked bond
The yield on the benchmark 10-year Japanese government bond rose 1.5bp to 1.630 per cent amid mounting speculation that the Bank of Japan would end quantitative monetary easing on Thursday.
JGBs also reacted to Friday’s sharp rise in the 10-year US Treasury yield.
But trading volumes remained thin with investors reluctant to take large bets ahead of Thursday’s decision. Many analysts still think the BoJ will wait until next month before ending quantitative easing.
Longer dated yields are usually higher than short dated ones since investors charge more for lending for longer periods of time. Any inversion, where longer dated yields are lower, traditionally implies the market is pricing in low returns as the result of a probable economic slowdown.
By late trade in New York on Monday, 10-year notes yielded 4.742 per cent, their highest since June 2004 and just 2.5 basis points below two-year yields.
Monday’s move was an extension of “curve flattening” trade unwinding which began last week after the inversion lost momentum with 10-year yields peaking about 16bp below two-year yields.
UK government bonds were marking time ahead of the Bank of England’s decision on interest rates later in the week.
Hopes of a cut have been damped by a string of data released in in the past couple of weeks showing some economic strength.
While 25 of the 40 economists polled by Reuters still think the next move in rates will be down, the market may have to wait until May for a decision, when the Bank’s rate setting committee will be armed with the next quarterly inflation report.
The yield on the two-year gilt was up 1.3bp at 4.399 per cent and the 10-year yield was down 0.1bp at 4.257 per cent.
European government bonds saw some small price gains, with yields slipping back from last week’s steady increases.
Eurozone data showed a drop in retail sales last month, illustrating the conundrum of lacklustre consumer activity even as exports and business spending accelerate.
The data contrasted with strong manufacturing and services numbers last week that had helped raise expectations of further interest rate rises to come from the European Central Bank. Germany has begun bookbuilding for its first inflation-linked bond
The yield on the benchmark 10-year Japanese government bond rose 1.5bp to 1.630 per cent amid mounting speculation that the Bank of Japan would end quantitative monetary easing on Thursday.
JGBs also reacted to Friday’s sharp rise in the 10-year US Treasury yield.
But trading volumes remained thin with investors reluctant to take large bets ahead of Thursday’s decision. Many analysts still think the BoJ will wait until next month before ending quantitative easing.
# posted by Dr Search- Principal Consultant at the Search Clinic @ 11:05 AM 0 comments
links to this post
Monday, March 06, 2006
US loans rates- an uneasy calm
The calm is eerie. After a few years of strong economic growth, tame inflation, predictable monetary policy moves and continued overseas demand for US assets, volatility in the bond market has fallen dramatically.
The Merrill Lynch Option Volatility Estimate index, which tracks the implied volatility of one month options on different Treasury bonds, has fallen to levels last seen in mid-1998.
Can the peace calm? There is no clear reason why it should end soon. As Alan Greenspan underlined in his comments about the bond market “conundrum”, longer-term yields have proved largely immune to changes in monetary policy.
While short rates have risen sharply in the past two years, 10-year yields are broadly flat. Monetary policy under Ben Bernanke is likely to become more transparent. So even though rates are potentially nearing an inflection point, that need not necessarily mean that markets will get caught off guard.
And certain technical factors that help underpin demand for Treasuries, such as liability matching for pension funds, will continue.
However, there are risks. If the US economic data shift decisively, for example with a spike in inflation, that would break investors’ complacency. Alternatively a sudden deterioration in the outlook for US growth could have a similar effect.
If history is any guide, a shock could equally come from abroad. Anything that triggered a rethink by overseas investors on the attractiveness of US assets could cause a rapid rebound in volatility in the Treasury market.
Such events are very tough to predict. But they happen. Last time things were this sleepy, there was a rude awakening when the Russian default sent markets into a tailspin.
The Merrill Lynch Option Volatility Estimate index, which tracks the implied volatility of one month options on different Treasury bonds, has fallen to levels last seen in mid-1998.
Can the peace calm? There is no clear reason why it should end soon. As Alan Greenspan underlined in his comments about the bond market “conundrum”, longer-term yields have proved largely immune to changes in monetary policy.
While short rates have risen sharply in the past two years, 10-year yields are broadly flat. Monetary policy under Ben Bernanke is likely to become more transparent. So even though rates are potentially nearing an inflection point, that need not necessarily mean that markets will get caught off guard.
And certain technical factors that help underpin demand for Treasuries, such as liability matching for pension funds, will continue.
However, there are risks. If the US economic data shift decisively, for example with a spike in inflation, that would break investors’ complacency. Alternatively a sudden deterioration in the outlook for US growth could have a similar effect.
If history is any guide, a shock could equally come from abroad. Anything that triggered a rethink by overseas investors on the attractiveness of US assets could cause a rapid rebound in volatility in the Treasury market.
Such events are very tough to predict. But they happen. Last time things were this sleepy, there was a rude awakening when the Russian default sent markets into a tailspin.
# posted by Dr Search- Principal Consultant at the Search Clinic @ 9:52 AM 0 comments
links to this post
