Thoughts on Three Issues Ahead of the Weekend
Ahead of the weekend, three are three key talking points: implications of yesterday's BOJ decision, ECB outlook and US jobs data.
Contrary to our expectations, the BOJ did surprise the market yesterday. There was initially follow through yen selling, lifting the dollar to JPY97.20 at its best and lifting the Nikkei almost 5% and driving 10-year JGB yields down to almost 32 bp. However, by late Asia, profit-taking set in. The dollar fell briefly below JPY95. And the Nikkei, which had gapped higher at the opening (in the wake of the yen's weakness), retreated and managed to finish on the lows of the session, and almost 0.5% below opening levels (though still above Thursday's high). The JGB 10-year yield finished up 8 bp on the day, with an even large rise in the belly of the curve (6-9 years).
In a nut shell, the BOJ plan is really a doubling down on the previous LDP strategy. It will be buying about JPY7.4 trillion in JGBS, up from about JPY4 trillion now. It will increase the average maturity from 3 years to 7. It intends to increase its monetary base from JPY138 trillion at the end of last year to JPY200 trillion by the end of this year and JPY270 trillion by the end of next year. This will be largely reserve deposits which will rise from JPY47 trillion to JPY175 trillion.
The creation of new reserve deposits will not have much impact on the economy if they simply stay in such accounts. To be effective funds have to be used. It is true, and we will be reminded again next week with the latest data, but bank lending has been rising in Japan. It is up for more than a year. However, the rise is small and largely a function of reconstruction efforts. Japanese businesses do not seem starved for cash. They are mostly self-financing through retained earnings. In addition, the recent Tankan survey showed plans to cut capex. Our analysis suggests that Japan's problem is not a shortage of capital but its excess.
That said, while we are skeptical of the efficacy of the BOJ's strategy, we do see how inflation can rise in 2014 and 2015. It is not so much through monetary policy as the fiscal legacy of the DPJ. The increase in the retail sales tax in both 2014 and 2015 would lift measured inflation. In the past, the BOJ has said, it would look through the tax-induced increased of inflation, but it is not clear that the Abe government would look such a gift horse in the mouth, so to speak.
The euro's rally after touching new lows for the year yesterday seemed to be largely a product of plays against the yen rather than something particularly inspiring from ECB President Draghi. The revelation of an extensive rates discussion and the more dour economic assessment and the pledge to watch developments closely, combine to raise the odds of a repo rate cut as early as next month. We had anticipated a cut later in Q2 or even in July, which is when last year's cut was delivered.
The significance of Draghi's comment that Emergency Lending Assistance (ELA) is not senior is continues to be digested. The different national ELA programs are consolidated on the ECB's balance sheet. Yesterday the ECB's show a large rise, this ostensibly reflects Cyprus, but it also may reflect others as well, like Greece and Portugal. As a side note, it is possible that Portugal's court decision on the legality of the austerity (brought by the President) is handed down today. It could strike down some tax increases and public sector pay cuts.
The main event today and the last ahead of the weekend is the North American employment reports. Canada is expected to have grown 6.5k jobs in March after a sharp 50.7k increase in Feb. Canada reports the Feb trade balance at the same time and the first surplus since last March is expected. However, the Canadian data will be overshadowed by the US jobs report. While the consensus is for an increase of 190k jobs according to the Bloomberg consensus, we suspect the actual expectation has slipped and there is a whisper number of 150k.
In the last two years, there have been short-lived spurts in net job creation. What seems to be happening now is that lay-offs have dropped to near pre-recession levels, but the economy, while producing about 5% more than it did at the last cyclical peak, is doing so with 3 mln fewer jobs.
We recognize that economists have caught up to our sense that after a dismal Q4, the economy was going to be moire resilient in Q1 than expected. And indeed it has, as reflected in upward revisions to GDP forecasts, with some investment banks talking about a 3-handle on Q1 GDP. However, our concern now is that the consensus is still out of step and the economy is set to disappoint. We got a taste of it with the ISM readings and the ADP report (which for the last five months the preliminary ADP missed by an average of 5k the preliminary BLS).