Below we look at the Bank of Japan, the Fed, global central bank tightening, rising yields, currency hedging, and bond market sell-offs.
France to Japan
Sitting today in the warm sunshine of France, it may seem otherwise odd to be turning my American thoughts toward places like Tokyo, but, alas, there’s news from the Bank of Japan (BOJ) worth a paragraph or two here.
Ah, the central banks…
From the US and EU to Asia, we have seen these magical money printers essentially buy the world a “recovery” in the wake of the ’08 disaster.
For any who have read my thoughts on these distortive monster banks, the theme is clear: By refusing to allow the world’s credit markets the necessary (and deserved) pain of a recession then, these banking magicians have done nothing but buy time–creating massive bubbles in everything from global securities to real estate, which will bite us much harder later.
In short, today’s “feel good” markets have become more dangerous. By postponing the pain, the central banks of the world have only created a scenario of much worse pain ahead.
Think about it: If you’re a broke drunk making no income and living beyond your means, a cold shower and steady job are what you need. The same is true of markets. But if a rich uncle keeps handing you drinks and paying your bar tab, no lessons or cure will come.
When the Fed, for example, postpones a hangover buy purchasing 70% of America’s Treasury bonds and sub-prime debt, that is not a “detox” but merely a delayed hangover. Stated simply, at some point, markets, like drunks, need to sober up and walk on their own two feet…
The Bank of Japan Tightens
In Japan, like the U.S., such cold-showers have instead been replaced by years and years of free drinks in the form of “Quantitative Easing” (QE). But as we are seeing both in DC and Tokyo, the bar bill is about to arrive as the central banks of both Japan and the US are closing rather than extending their “tab.”
That is, the shift from QE to QT has begun. Let’s look at the numbers and implications behind this critical pivot.
During the past months, the BOJ—arguably the world’s greatest monetary drunk (and money printer per capita) has begun to sober up, recently dropping its asset-purchasing binge by over 60%.
In the last year, it has begun tapering from its insane $850B annual QE purchases (representing nearly 20% of Japan’s GDP) to a rate now of just $320B (June 30, 2017 to June 30, 2018).
Let’s put this into some perspective. In essence, Japan in 1989, like the US in 2008, was broke. No one would buy its sovereign debt or public stocks. A major re-set and recession were thus inevitable.
So, what did the BOJ do?
Like the US Fed, it simply ignored supply and demand, market correction Karma, and recessionary lessons and “bought” its own market recovery.
As a result, the BOJ now owns nearly 50% of Japan’s monstrous sovereign debt and has become the personal and leading shareholder in 90% (!!!) of Japan’s publically traded stocks/companies.
Does that sound or look at all like natural capitalism? It looks more like someone who goes bankrupt ordering new credit cards to pay prior ones.
When a central bank, rather than actual market participants, floats an entire economy and securities bubble and then calls that a “solution,” pain can only be postponed, not avoided. And the pain is coming.
You see, Japan’s number one asset-buyer (the BOJ), is running out of “stimulus.”
They simply can’t print money forever to keep the market binge party going. And as their country’s bar-tab paying central bank pivots from “unlimited” to “closed,” guess what happens to all the investing party-goers hoping for another free beer?
Their buzz goes away—and the hangover looms. In short, a market supported by central bank money printing, asset-purchasing, and low rates dies when each of those central bank “supports” goes away.
It’s as plain as day, and yet hardly anyone is noticing.
The “genius” central bankers who began this party years ago made a historically tragic, as well as, experimental assumption that such “support” (i.e. debt and money printing) would be worth the bar bill if natural growth and GDP expansion counter-balanced (i.e. justified) the cost.
After all, markets addicted to easy money, like drunks addicted to free drinks, don’t behave very, well…productively.
Instead, they “party on.” In market terms, that means they speculate—they go on a shopping spree. Markets, thereafter, skyrocket.
And since the Nikkei crashed in 89, and the S&P tanked in 2008, that’s precisely what we’ve seen in the record high stock, bond, and real estate markets here and abroad: a party masquerading as a “recovery.”
But this recovery has nothing to show for it in the real-world metrics of GDP, natural growth, or Main Street economic strength. In short, these central banks, currently the “heroes” of today’s global “market recovery” are about to be the goats of tomorrow’s hangover regrets.
It’s actually pretty sickening. I can’t underscore enough how historically at fault these central banks shall one day be for pushing the world into a major recession.
I mean, just do the math folks, for the sins of central banks like the BOJ and the Fed are now global rather than regional.
All the Central Banks Are in the Same Mess
Between 1998 and today, for example, the central banks of the WORLD have collectively printed $20T to scoop up their own (and otherwise unwanted) sovereign and corporate debts. $20T.
Read that again: t-w-e-n-t-y- T-R-I-L-L-I-O-N. $20,000,000,000,000.
The Swiss National Bank even used printed money to buy stocks, and the Japanese did the same with ETF’s. Needless to say, in the short-term, $20T in the global wallet looks and feels really good. That much fiat money printed out of thin air provides lots of time to buy your own markets—aka drinking your own spiked Kool aide.
The Fed, of course, deserves a “hurrah!” for leading this party.
But the pivot from binge-drinking support to sober reality which began with the Fed this year (and the BOJ in tow), has now begun…
In other words: uh-oh.
Leading the Way in Dumb: The US Federal Reserve
As the Fed raises rates and begins dumping rather than buying America’s Treasury debt, the rest of the equally drunk central banks of the world have no choice but to follow a similar policy of cold-showers and monetary tightening.
That is, they’ll be forced to shrink their balance sheets (and their market “bar tab”) as well.
Because if they don’t, all that printed money that the central banks created in Euros, Franks, Yuan, Yen etc. to keep up with the US/Fed binge party will suffer dramatically plunging FX rates (and dramatically rising inflation in their respective countries); capital flight will then follow…
That is, as the central banks of the world expanded their balance sheets to $20T, they simultaneously accumulated massive amounts of dollar-denominated liabilities in their own central bank accounts.
To keep their own currencies within strength-parity with the USD (i.e. to suppress their own FX rates), they had (and have) no choice but to engage in perpetual currency market intervention—i.e. “hedging.”
But such currency-intervention carries a series of skunks in the long-term woodpile.
Let me explain—and distill the complex fog of currency markets into the lighthouse simplicity of the mess we are now in.
You see, as the Fed printed trillions of fiat money out of thin air and cranked rates to near 0% in the post-08 “recovery,” the other nations (and hence currencies) of the world were forced to follow suit (and our dollar) by hedging their own currencies against the greenback.
This was fine if and when US rates were cheap/low, as the hedging costs were equally cheap and low.
But as the US begins its pivot from the Fed’s low-rate binge-party (i.e. “QE”) to a sobering rising-rate reality (i.e. “QT”), the subsequent rising US yields, dollars, and exchange rates are gonna hurt everyone—and all at once.
Stated otherwise, the cost of hedging into USD-denominated securities (including derivatives) for foreign investors is about to get very expensive—and thus very painful for global markets.
Take, again, the Japanese as an example. As their absurdly drunk central bankers printed money to prop up local markets, they cranked their own bond yields to the floor (.05%)—because remember: when a central bank buys its own country’s debt, the price of their bonds artificially rises and thus their rates/yields, inversely, fall.
The same thing happened to yields in Europe and China—sometimes to negative levels!
And thus Japanese, Chinese, and European investors (like my pals here in France this summer) had to scramble for yield somewhere. But where could they find it? Sadly—and as Willie Nelson said it best: “in all the wrong places.”
Namely, global investors had to go further and further out on the risk branch to get any kind of yield/return on their investments. So, like a herd of blind sheep, they clambered into US high yield markets (aka “Junk” bonds) and highly-levered (aka dangerous) CLO paper.
(Remember that “CLO” paper in the 08 crisis—the “collateralized loan obligations”? It is just Wall Street fancy-speak for crappy, levered layers of high-risk debt).
But as the dollar strengthens in the new rising rate environment, whatever “yield” foreigners were getting for junk bonds is being eaten away by the higher cost of the USD.
In short, foreign investors in US bonds are eventually gonna have no choice but to sell those margin-less bonds.
Back to the Bond Market
And guess what happens when bonds are sold en masse? Rates rise. And thus, we see a perfect storm and vicious circle in play here.
That is, as the Fed begins its “forward-guided” bond selling campaign in late 2018, and as the Chinese and others start starting dumping US bonds to pay for trade war losses, and as other foreign investors begin selling US bonds whose currency costs are eating away at any margins they may have otherwise enjoyed, the net result is simple: bond sell-offs.
And bond sell-offs means falling bond prices and thus rising rates, and rising rates in a world already soaked in debt means only one thing: a debt crisis.
That is, hangover time is inevitably going to replace the party time which our central banks unleashed in the post-08 “New Normal” –meaning it is only a matter of time before the historically grotesque bubble we’ve seen driven by stock buy-backs, levered re-caps, bad (i.e. over-priced) M&A deals, and debt-powered (i.e. unearned) dividends comes to a popping and karmic moment.
So, I’ll say it again and again: If you want to know about where the stock market and recession signs are heading, you need to know, understand, and track the bond market.
In sum: keep your eyes on rising rates.