From a global macroeconomic perspective, we encourage readers to consider that the world is experiencing an extended, rolling process of deflating its credit excesses. It is now simply China’s turn.
For context, Japan started deflating their credit bubble in the early 1990s, and has now experienced more than 20 years of deflation and very little growth since. The US began its process in 2008, and after eight years has only recently been showing signs of sustainable recovery. The euro zone entered this process in 2011 and is still struggling six years onward. We believe China is now entering the early stages of this process.
Having said that, we believe that Chinese authorities have a viable plan for deflating their credit excess in an orderly fashion. Please stay posted as we will review this multi-pronged, market-based approach in our next column.
For now, let’s turn our attention to the size of the credit excess that China created and why we estimate it to be the largest in the world.
A credit excess is created by the speed and magnitude of credit that is created – if too much is created in too short a time period, excesses inevitably occur and non-performing loans (NPLs) emerge.
To illustrate the credit excess that has been created in China, let’s review several key indicators, including the: 1) flow of new credit; 2) stock of outstanding credit; 3) credit deviation ratio (i.e., excess credit); 4) incremental capital output ratio (efficiency of credit allocation).
The chart below shows the amount of credit created as a percentage of GDP during the five years prior to major downturns globally.
A novel dilemma for the European Central Bank to contend with: above target inflation.
Prices in the single currency area have climbed by 2 per cent on the year for the first time in over four years, posing a fresh headache for the ECB’s dovish policymakers who will mark their two-year quantitative easing anniversary next week.
At the ECB’s latest meeting next Thursday, president Mario Draghi will face the task of convincing his more hawkish colleagues that the current leap in annual prices – from 1.8 per cent in January – is unlikely to be sustained having been driven by volatile energy costs. The central bank, which has been battling with more than three years of low prices, targets inflation of just under 2 per cent.
Here’s what analysts are making of Mr Draghi’s dilemma.
Despite the recent upsurge in inflation driven by higher oil prices Pete Vanden Houte at ING thinks inflation will begin to stabilise over the coming months. If anything, he says the ECB will opt to let inflation run above target to compensate for years of weak prices:
There is little doubt that the ECB will continue to be criticized for its loose monetary policy, especially in the core countries. But the bank will no doubt recall that the inflation target has to be reached over the medium term and for the whole of the Eurozone. If anything the ECB is more likely to err on the side of inflation, to compensate for the fact that consumer price increases have significantly undershot the ECB’s target for now 4 years in a row.
We therefore don’t see any change in monetary policy this year. However, in the third quarter, the ECB might announce its exit strategy, which in our view will probably entail a new extension of the QE program until mid-2018, but with some tapering included.
While Bank of Japan officials see no grounds for Donald Trump’s accusation of currency devaluation, they still worry that the bank’s unique measure to control long-term rates could become the next target as the president continues his rhetorical battles.
“I have no idea what he is saying,” said one baffled BOJ official after learning about the criticism Trump leveled against the central bank.
Bond investors seem similarly perturbed. Yields on 10-year Japanese government bonds temporarily rose 0.025 percentage point Thursday, hitting 0.115% — the highest since the BOJ announcement of negative interest rates Jan. 29, 2016. The climb also reflects market anxiety over whether the central bank will continue buying up JGBs at the current pace.
BOJ Gov. Haruhiko Kuroda refuted Trump’s accusation in the Diet on Wednesday, saying Japan’s monetary policy is designed to defeat persistent deflation and not to keep the yen weak. “We discuss monetary policy every time Group of 20 finance ministers and central bankers meet,” he said. “It is understood among other central banks that [Japan] is pursuing monetary easing for price stability.”
In fact, U.S. monetary policy is chiefly responsible for the yen’s depreciation against the dollar. The Federal Reserve in 2015 switched to a tightening mode after keeping interest rates near zero for years, judging quantitative easing to have worked its expansionary magic on the economy. The gap between American and Japanese rates is now the widest it has been in around seven years, encouraging heavier buying of the dollar — the higher-yielding currency — than the yen.
The Bank of Japan revised its economic outlook for the first time in 19 months during the two-day policy meeting that ended Tuesday. But that is apparently the only step the central bank is taking at this time.
“The headwinds seen in the first half of this year have ceased,” BOJ Gov. Haruhiko Kuroda told reporters following the meeting. Markets were riled by heightened concerns directed at emerging economies at the beginning of 2016, only to be shocked in June by Britain’s referendum to exit the European Union. The BOJ was forced to loosen its policy in July, raising its target for exchange-traded fund purchases.
During the second half of 2016, the economic landscape has slowly brightened, beginning with U.S. readings. The Japanese economy has followed suit with increased exports and production. Consumption also recovered from a slump caused by a soft stock market and inclement weather at the beginning of the year.
“Japan’s economy has continued its moderate recovery trend,” the BOJ said in a statement published after the meeting. The central bank had previously qualified that view by highlighting sluggish exports and production.
Bank of Japan Gov. Haruhiko Kuroda admitted for the first time his disappointment at not being able to reach its target of 2% inflation within the two-year deadline originally set.
Kuroda entered office in March 2013, promising to reach 2% inflation at the earliest possible time, initially with “two years in mind.” Almost four years on, and despite throwing everything but the kitchen sink at Japan’s deflation problem, he has not been able to deliver on the promise.
Kuroda did not stray from his usual tactic of blaming external factors on Tuesday after the BOJ’s two-day policy meeting. The governor cited the fall in oil prices, weak consumer spending after the consumption tax hike and the slowdown in emerging market economies as contributing factors. “The situation is similar with the central banks in the U.S. and Europe as well,” Kuroda said. But ultimately he was forced to admit he was “obviously disappointed that 2% inflation could not be achieved within 2 years.”
Despite the weaker than expected US jobs report, the dollar remains firm and EM is ending the week on a soft note. The main culprit was higher US rates, with the 2-year yield moving up to 0.85% and is the highest since early June. Concerns about Brexit impact and as well the health of European banks remain ongoing and could weigh on risk sentiment this coming week. Lastly, oil may come under more pressure after Russia said it sees no deal with OPEC at next week’s World Energy Congress meeting in Turkey.
China returns from a week-long holiday, and markets may be a bit nervous after it reported lower than expected foreign reserves for September. Taken in conjunction with the softer yuan, capital outflows from China may be picking up. Elsewhere, the central banks of Korea, Peru, and Singapore hold policy meetings, though no changes are expected.
China reports September money and new loan data sometime during the week, but no date has been set. It reports September trade Thursday. Exports are expected at -3.3% y/y and imports at +0.7% y/y. It then reports September CPI and PPI Friday, with the former seen rising 1.6% y/y and the latter falling -0.3% y/y. The PBOC has been on hold since October 2015, when it cut its policy rates by 25 bp. If the slowdown remains modest, we do not think PBOC will ease further for fear of encouraging debt-fueled growth. We think the easing cycle is over.
With inflationary pressures ebbing and likely to fall further after a good monsoon, the Reserve Bank of India (RBI) could well trim the key repo rate by 25 basis points when it reviews monetary policy on October 4.
The central bank last cut the repo rate by 25 basis points to 6.5% on April 6, taking it to the lowest level in six years. The cut would be aimed at getting banks to drop loan rates thereby boosting demand for credit at a time when growth has been subdued.
Consumer inflation for August came in at 5.1% year-on-year and is expected to nudge closer to 4.5% y-o-y by December, well within the RBI’s comfort zone. While there are those who believe the central bank might hold off till December so as to get a better idea of the kharif output, others believe fairly good visibility on inflation would persuade the RBI to trim rates now. That’s because banks have not lowered their lending rates meaningfully even though borrowing rates have dropped sharply in the money markets—both at the long and short ends.
Samiran Chakraborty, chief economist at Citibank, observed the August CPI had opened up the possibility of a 25 basis points rate cut in the October 4 policy. “The upside risks envisaged by the RBI to its March 2017 CPI target have substantially diminished now,” Chakraborty wrote in a recent report. A good monsoon, he believes, should keep food prices in check estimating an average 0.5% month-on–month seasonally adjusted increase till March next year which is marginally lower than in the corresponding period of FY16. “These factors can push headline inflation closer to 4% by December,” he wrote.
Although the Bank of Japan’s pivot toward interest rate controls has been the subject of much interest, Gov. Haruhiko Kuroda was mostly focused on an entirely different issue when forming the new monetary framework: how to ensure the ultraloose stimulus continues even after he steps down.
On Sept. 21, which capped the two-day monetary policy meeting, the BOJ vowed to keep expanding the monetary base until the inflation rate exceeds the 2% threshold “and stays above the target in a stable manner.” The conventional wisdom in the U.S. and Europe is that central banks should aim for price increases of 3-4%. That view was a hot topic during the late-August gathering of central bankers in Jackson Hole, Wyoming, which Kuroda attended. Deflation is becoming a bigger risk than inflation, goes the argument.
For Kuroda, it was only natural to show a fiercer resolve toward beating deflation, said a BOJ official. The fact that the BOJ chief is sticking with the epoch-making easy money policy is also rooted in the mistakes made by the central bank in the past.
Morgan Stanley: It’s Not About Easing For JPY; Its About Inflation Expectations.
The evolution of inflation expectations is dominant for the assessment of the JPY. Hence, the BoJ’s monetary policy statement due on Wednesday must be checked in respect of its impact on Japan’s inflation expectations. -Cutting rates and redirecting QE into the front end of the JGB curve may steepen the curve, but does little to support inflation expectations. –However, lifting the BoJ’s inflation target or the MoF announcing plans to increase the duration of its liability book could help in pushing inflation expectations higher. In this case, the BoJ yield curve steepening exercise would be part of a comprehensive strategy to reflate Japan. Should the yield curve steepening just come in isolation with no hint of how to increase inflation expectations then the JPY will continue to strengthen.
Barclays: JPY Set To Rally On BoJ Inaction –
We expect no BoJ easing this week. The Bank of Japan (BoJ) MPM (Wednesday) is be the main focus of this week and we expect BoJ to refrain from the further easing this time, but the BoJ could take a more flexible stance on the time horizon for reaching its price stability target of 2% and change the annual pace of increase in its JGB holdings to JPY70-90trn from the current JPY80trn. There is a risk that the BoJ will decide to take interest rates deeper into negative territory and become more flexible in its JGB purchases, as reported by several media sources (Nikkei, 14 September 2016) or the BoJ will raise expectations for further easing. According to a survey conducted by Bloomberg on 7-12 September, 54% of the respondents forecast further easing in September, of which, 61% expected deeper negative interest rates, 57% projected an increase in longterm JGB buying, 52% looked for an expansion of the monetary base, 30% predicted more JREIT purchases and 9% expected an increase in equity-linked ETF buying. Under our base scenario of no further BoJ easing, we expect some JPY appreciation after the MPM, but we should take a note that FOMC rate announcement is on the same day. Hence, USDJPY movement could also be affected by the FOMC decision. Under our risk scenario where the BoJ eases with a focus on further cuts to negative interest rates with measures to steepen JGB curve (or raises market expectations for further easing in the future), we expect JPY depreciation pressure to strengthen, at least in the near term. In assessing the durability of JPY depreciation in such case, the balance between scope and effectiveness of further easing via NIRP versus headwinds from JPY’s undervaluation and heightened global uncertainty will be the key
Amid strong speculation the Bank of Japan will further loosen credit at Wednesday’s monetary policy meeting, a former board member cautioned further stimulus may send the wrong message to the market.
Speaking at a web seminar in Tokyo, Keio University professor Sayuri Shirai on Tuesday warned the flexible bond-buying target that many market participants expect the BOJ to adopt will be confusing. Shirai was a member of the BOJ policy board until March.
The central bank’s annual bond-buying target is set at 80 trillion yen ($786 billion) per year. Many economists and market players believe the BOJ broaden the target range to 70 trillion yen 90 trillion yen. Shirai stressed the buying target “should not be ambiguous” because it “is an indicator that shows the BOJ’s stance toward monetary easing.
“A target that stretches [above and below the present target] is not appropriate as an indicator of monetary policy.” If such a target is introduced, the market will be confused as to whether the BOJ is taking a more accommodative policy a or tighter one, which could contribute to market volatility, she said.